What is the Dollar’s Outlook Post Payrolls?

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Friday’s U.S. jobs report was not only strong enough to prevent the dollar from sinking below 115 against the Japanese Yen but also hot enough to take the currency pair above 117. Economists were looking for job growth to fall to 175K but instead non-farm payrolls increased by only 156K in the last month of the year.  Not only was this decline larger than expected but it was also the second weakest month for job growth since May.  The unemployment rate also rose to 4.7% from 4.6%, which was in line with expectations but that’s where the disappointments end.  Although payrolls fell short of expectations, job growth in November was revised up from 178K to 204K.  The labor force participation rate also increased, explaining the rise in the unemployment rate but most importantly, wage growth rose by 0.4%, the strongest pace since 2009. This also exceeded the market’s lofty 0.3% forecast.  All in, these numbers won’t change the Fed’s plans for tightening.  In fact, Fed President Mester who votes for the first time this year came out shortly after the release to say that December’s jobs report was a decent one.  However Fed fund futures were unchanged following the data even though U.S. rates and the U.S. dollar shot higher.
 
Liquidity returns fully in the week ahead and the focus will be primarily on Fed speak as we don’t have any meaningful U.S. data scheduled for release until the retail sales report on Friday.  There are 7 Federal Reserve members with speeches from now until Friday, 5 of whom are voting members of the FOMC this year.  That includes Fed Chair Janet Yellen, Fed Presidents Kashkari, Powell, Harker and Evans.  Recent comments from Harker and Yellen have been hawkish whereas Kashkari, Powell and Evans have been more cautious.  With that in mind, we expect the dollar to consolidate with USD/JPY trading between a 115 to 117.50 range.  The Fed isn’t going to be raising interest rates anytime soon so for the time being, gains for the over stretched dollar could be limited but at the same time, pullbacks ahead of Trump’s inauguration should be shallow.
 
Aside from the moves in the U.S. dollar, the second big story in the forex market this past week were the interventions by China and Mexico’s central banks. On Friday, the People’s Bank of China hiked the CNY rate the most in 11 years pushing the currency up by more that 1% against the buck as it trues to support the unit ahead of the Chinese Near Year holiday at the end of the month.  Between the rise in the U.S. dollar, uncertainty about China’s economy and capital outflows, the yuan had been under significant pressure over the past few months, coming close to breaching the 7.0 mark, a level not broken in over 8 years.  However in order to stem the outflows and halt the one way trade, the central bank has been aggressively fighting off speculators.  Aside from intervening in the currency, they also sent offshore yuan rates sharply higher, making it exorbitantly more expensive to borrow or “sell short” the currency overseas.  According to the Wall Street Journal, “The rate that banks charge each other in Hong Kong’s overnight lending market for the yuan jumped to 61.3% on Friday–the highest in a year and the second highest level on record. That rate was 38.3% on Thursday, and has remained above 10% since Dec. 30.”  Unfortunately intervention doesn’t always work especially when the fundamental factors driving down the Yuan are so significant.  The outflows have been motivated by the hunt for yield outside of China and the prospect of further rate hikes from the Fed.  In the near term however, the reversal in the currency helps to brighten the outlook for Australia and New Zealand’s economy. While AUD and NZD had a good start this year, the momentum could be waning as key resistance levels lie above.  With that in mind, Australian data has been fairly good (both of the December PMI reports surprised to the upside) and the trade deficit unexpectedly turned to surplus in November. This contrasts with a continued decline in dairy prices in New Zealand. Australian retail sales is the only piece of data scheduled for release from either country next week and another strong report could help AUD/NZD close above 1.05 or the first time in more than a month.
 
Meanwhile the reversal in USD/CAD has been both sharp and aggressive.  Part of that can be tied back to the sell-off in the U.S. dollar but oil prices have been on the rise with solid improvements in Canadian data.  Like Australia, Canada’s trade deficit turned into a surplus in the month of November.  This was significantly better than expected because economists were actually looking for a bigger deficit.  More than 53K jobs were also created in December (all full time) and manufacturing activity expanded at its fastest pace since January according to the IVEY PMI report.  This leads us to continue to expect further gains in the Canadian dollar, particularly against the euro, sterling, Swiss Franc and New Zealand dollars.
 
This week’s better than expected Eurozone economic reports also helped to drive EUR/USD above 1.06. Although the currency pair ended the week below this key rate, the move above 1.05 marked a significant near term bottom. According to the latest Eurozone reports inflation is on the rise, confidence is up and economic activity (led by gains in the service sector) was stronger than initially estimated in December.  The same improvements were seen in Germany with the labor market also reporting fewer unemployment claims.  The only “bad news” came on Friday when we learned that retail sales fell two times more than expected in Germany and factory orders dropped -2.5%.  However even then the losses were relatively modest despite the dollar’s rise post payrolls, which goes to show that EUR/USD may have really bottomed (for now).  Looking ahead, if EUR/USD dips to 1.05 it could present a nice short term buy opportunity back up to 1.06.  German industrial production, trade and current account numbers are in focus next week along with the ECB’s account of their latest monetary policy meeting.
 
Sterling on the other hand struggled throughout the first week of January against the U.S. dollar and euro despite stronger data and the rise in Gilt yields.  The latest PMI reports show improvements in the manufacturing, service and construction sectors and yet these upside reports provided little support to pound.  Investors are still nervous about Brexit as the Supreme Court has yet to make its decision on Article 50.  While their announcement will most certainly elicit some type of response in the currency, the main focus this year will be on the terms of exit.  The procedures such as Parliament’s role will only stand to delay the inevitable.  Most members of Parliament prefer a softer exit, but some hardliners want to put immigration above everything else, leaving Britain at risk of losing access to the single market. The best case scenario for the U.K. economy and sterling would be if the U.K. remains within the single market that allows for tariff free movement of goods, services, money and people within the EU but such favorable terms are unlikely.
Regards All.
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